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Europe Funds the Last Ponzi Game Standing

For the past year or so I have espoused the opinion that chaos in Europe is good for the US because of capital flight from Europe to the US. That capital is funding the Last Ponzi Game Standing, the US Treasury market and US economy.

Here’s how that works. As Europe destabilizes, big money exits the problem markets of Greece, Portugal, Ireland, Italy, and particularly Spain. Ireland and Italy have stabilized somewhat in recent months, but money is still pouring out of Greece, Portugal, and Spain. Much of it is transferred to the US to purchase Treasuries and probably big cap stocks to some degree. These purchase funds flow into the US Treasury and US bank accounts. The Treasury subsequently spends the cash it borrowed from these sources, and it ends up in US bank accounts.

Of every dollar the US Government spends, on average over the course of the year approximately 35 cents comes from borrowing. Some of that borrowing comes from domestic sources. About 8% of it over the past year has come from foreign central banks. Of the rest, the US Treasury TIC report says that Europeans made net purchases of $76 billion of US Treasury Bonds in the second quarter. That was equivalent to 30% of the new Treasuries issued. In other words, it appears that European capital flight accounted for 30 cents of every dollar of debt the Treasury raised. That debt accounted for 35 cents of ever dollar the government spent. Therefore, roughly 10 cents of every dollar of US government spending driving the US economy came from European capital flight.

Given those cash flows, anyone who argues that what’s bad for Europe is bad for the US is simply wrong. If Europe somehow manages to ameliorate its problems, or even create the impression that it is doing something to solve them, then these flows would slow down or even stop. The obvious effect would be that long term US bond yields would be forced to rise in order to attract investors. Alternatively, the US government would need to spend less or tax more in order to reduce borrowing. Any of those outcomes would slow the economy. The other option would be for the Fed to step into the breach to monetize the debt. No doubt that would have an immediate response in the commodities pits, driving the cost of energy, materials, and food into the stratosphere, which in turn would crush the US economy.